J.C. Penney Plunges 15% as Goldman Sachs Disses Debt

Yesterday, J.C. Penney (JCP) traded a new 52-week low. Today, the stock has outdone itself by falling to its lowest level in more than 10 years.

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When a stock is in freefall like this, the reason doesn’t really matter. We know what’s wrong with the company at this point: Sales are hemorrhaging and the company has done nothing to refute the notion that it needs more cash. But today’s selloff–the stock has dropped 15% to $10.10–appears to be the result of a report released by Goldman Sachs report released yesterday that started coverage of J.C. Penney’s debt at Underperform. You know things are going badly when it’s the debt that’s in focus, not the stock.

Goldman’s Kristen McDuffy and Ryan Gallant explain the reason for the rating:

In our view, a combination of weak fundamentals, inventory rebuilding, and an underperforming home department will likely challenge J.C. Penney's liquidity levels in 3Q. In order to safeguard against a potentially poor 4Q holiday season, it is likely that management will look to build a bigger liquidity buffer, as has been suggested by recent press reports. Although we believe this would be a prudent measure for the company, given our expectation for new capital to come in the form of additional debt (rather than equity), we believe this will be a negative catalyst for creditors. We expect 3Q and 4Q to be difficult, with comp store sales likely showing a slower-than-expected improvement, and for the general retail environment to remain challenging, increasing the risk of a poor holiday season that the company can ill afford. As a result, we think that the next step for the company's debt is more likely to be wider than tighter.

And investors never want to hear the words “bankruptcy filing” in a report, even if only to say that such considerations are “premature.” McDuffy and  Gallant write:

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…although we believe handicapping a bankruptcy filing for JCP is premature, we do believe that understanding likely recovery values in the event of a bankruptcy is an important exercise. To that end, we view the term loan as the safest liquid instrument in the capital structure given our base case of a par recovery. We expect recovery on the unsecured bonds to range from 47-65%. However, under the scenario where the company issues $500mn of incremental secured debt, the recovery range would fall to 35-54%.

Is anyone trying to catch this falling knife?